On July 11, 2019, the Supreme Court of Canada (the SCC) granted leave to appeal from the Alberta Court of Appeal's decision in Capital Steel Inc v Chandos Construction Ltd, 2019 ABCA 32 [Chandos]. In a previous blog post, we considered the Alberta Court of Appeal's decision with respect to the enforceability of contract liquidated damages (LDs) upon the insolvency of one of the contracting parties. In this blog, we address the potential implications of Chandos with respect to the common law principle that an LDs clause may be unenforceable if it is found to be a penalty and not a genuine pre-estimate of damages.
General Law on Liquidated Damages ClausesLDs are commonly used in construction and other contracts to pre-determine damages for specific breaches of contract. For example, a general contractor may be required to pay LDs for each day beyond the required completion date taken to complete the work. In theory, by setting LDs in the contract, the innocent party can avoid the complexities and significant costs of having to prove actual damages before a court or arbitrator. However, in reality, even if two sophisticated parties have agreed to LDs in their contract, a court or arbitrator may find the clause to be a penalty, rather than a genuine pre-estimate of damages, and elect not to enforce it.
In 1914, the U.K. House of Lords in Dunlop Pneumatic Tyre Co. v New Garage and Motor Co., [1914] UKHL 861 [Dunlop] created a test to determine whether LDs are a penalty. Canadian courts adopted Dunlop in the 1915 decision Canadian General Electric Co. v Canadian Rubber Co., 52 SCR 349 at 352 [General Electric]. In General Electric, Chief Justice Fitzpatrick explained the difference between a penalty and an enforceable LDs clause as: "…[a] penalty is the payment of a stipulated sum on breach of the contract, irrespective of the damage sustained," while "…the essence of liquidated damages is a genuine covenanted pre-estimate of damage" (at 351). However, since General Electric, Canadian courts have struggled to apply the Dunlop test consistently, resulting in uncertainty in the business community.
More recently, the British courts reinvented the test for LDs in Cavendish Square Holding BV v Talal El Makdessi, [2015] UKSC 67 [Cavendish]. The U.K. Supreme Court reasoned that the prior law of penalties resulted in unsatisfactory distinctions. Rather, the Court held that the test should be whether an LDs clause protects any legitimate business interest, and...
